For as long as investment has been passionately pursued, the watchword has been diversification. Holders of stocks are routinely told to expand their bond position so that a turn in the market may be better weathered. Likewise, holders of fixed income securities are warned of the ravages of inflation, which may be best warded off through high growth but volatile stocks. Indeed, most investors think in terms of portfolio management, where their portfolio is carefully balanced to consider offsetting positions in various securities. Health Care stocks may combined with oil stocks; cyclicals combined with growth--each combination with the intent to dilute the negative impact that may strike one sector of the economy.
Typical in most investor's assets is some form of real estate investment. Real estate, as an investment vehicle, has attributes that are quite distinctive when compared to other forms of securities such as stocks and bonds. There are several methods of investing in real estate. First, and most often recognized, is the direct purchase of land or property--to be managed by the investor. Many a real estate empire has come and gone based simply on purchasing properties using borrowed money, with the expectation that the value and income of the property will exceed the interest paid on the loan. This is known as leverage, and with its great potential for success is the possibility of sizable failure. Other forms of real estate investment exist, all of which can be characterized as holding, derivative interest in property. This is done either by separate corporations, limited partnerships (REITS) or other bifurcated vehicles designed to limit the investor from the extremes of good and bad turns in the real estate market.
Surprisingly, most investors have sizeable if not dominating real estate holdings--without appreciating the substantial position taken. This, of course, comes about through the purchase of a home which in many areas of the country involves hundreds of thousands of dollars of borrowed money with the borrowing at significant interest rates. Indeed, the average investor with a portfolio of $50,000 may have a further position in real estate--due to their house--of another $350,000. In this scenario, the investors real estate position is 85% of the total portfolio. This is routinely referred to as being real estate "heavy" and runs counter to the established principles of diversification.
The repercussions of this are clear; down turns in the real estate market will dominate and deplete an otherwise well-balanced and successful portfolio of stocks and bonds. This has happened in the late 1980s in many areas of this country and many other industrialized countries, sizably reducing the net worth of many investors; whereas, the equity markets in general have performed well, real estate, at best, has been a turbulent market. There is, therefore, a great incentive for investors to dilute their real estate exposure. On the other hand, there are presently no investment vehicles to reduce this exposure in a cost effective manner.